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Interesting point. I took a quick look at the CPI weights, and there doesn't appear to be a breakdown for durables. In fact, it looks as though the CPI is designed to be a measure of the prices of flows (eg: housing costs are imputed rents), so CPI may not be much use at all in this context.

At the risk of over-simplifying this entire post - published CPI measurements are useless. Nick just says it with a lot more smarts!

Rick: thanks! But to be fair to the published CPI, it might be very useful for the job it was designed to do, just not very useful for our job now.

Stephen: thanks! I'm not 100% clear on this in my mind, but I think you might have hit the empirical nail on the head. A price index of domestically-produced new consumer plus producer durables would I think come close to what we are looking for, in practical terms. (Do GDP deflators break it down that way?) A price index of current consumption flows (like the CPI) is much less useful. It's the durable goods which ought to have the high interest-elasticity of demand, right? Not the consumption flows? (I can't quite get my head clear on this.)

I realised after writing the post that I had totally ignored a second theory of why we should be worried about deflation: Irving Fisher's Debt-Deflation theory. The definition of deflation useful for a DD theory would be very different, since it's the cumulative effect of deflation on the distribution of wealth between debtors and creditors that matters, not the real interest rate effect on current demand. Must get my head around that too.

I like the idea, but I'm skeptical of the thinking that "old house prices (pre-owned?) don't matter" for example. If existing house prices fall relative to new house prices, that too would reduce the sales of new houses. That might happen if the housing market overall falls more quickly than construction costs.

shan: I think you are right. But let's be more precise, because this is about the effect of the expected rate of change of prices on demand, not the effect of the level of prices on demand.

Suppose someone were just about to buy a new house. Then he suddenly changes his expectations about the price of old houses next year, expecting increased deflation, with no change to the current price of new and old houses, and no change to his expectations of deflation in new house prices. Instead of buying a new house now, as he initially planned, he might decide to wait until next year, then buy an old house. In other words, the cross-elasticity of demand between the price of future old houses (or the own real rate of interest on old houses) and current new houses is not zero. Future old houses are an (imperfect) substitute for current new houses.

This is similar to the effect I mentioned of deflation in new car prices on the demand for mechanics, except there the two goods (future new cars and current mechanics services) are complements, rather than substitutes, so it works in the opposite direction.

Dunno, but I think we should focus more on the own-elasticities rather than the cross elasticities, which could go in either direction, and maybe roughly cancel out in aggregate?

Oh, and if new and old houses were perfect substitutes (which is the over-simplified model I tend to have at the back of my head), then it wouldn't matter anyway, because new and old houses would always have the same price and the same rate of deflation. But their relative prices do seem to vary, so they can't be perfect substitutes. The biggest reason for this is probably that new houses are built on the edge of the city, while old houses are more central. Location matters more than the age of the house per se. Fluctuations in old house prices are mostly fluctuations in implied land values, which don't matter (except insofar as they affect the demand for new houses), because you can't produce more city centre land.

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